A blog by Jeffrey G. Marsocci, author of The Gay Marriage Alternative, focused on partner protection planning, plus legal and political news of interest to the GLBT community, domestic partners, and open-minded individuals.

August 21, 2009

Five Common Pitfalls in Domestic Partner Estate Planning, Part II

PITFALL 1) Using joint property to combine separate assets.

More than any other pitfall, this mistake can cost domestic partner couples thousands or even hundreds of thousands of dollars because of federal and state gift taxes. As mentioned previously, each person is only allowed to give another person up to $13,000 in any given year without any federal gift taxes. After that, the IRS imposes a gift tax on the giver of the money. So if Partner A gives Partner B $20,000 in cash, $7,000 is subject to federal gift taxes. The same thing is true when domestic partners take all of their individual property and assets and “put each other’s name” on the title. The effect is that half of the fair market value of all of both partner’s assets that exceed $13,000 is considered a gift to the other partner.

I can already hear some accountants and tax attorneys screaming “That’s not true! How dare you deceive these nice people who read your blog!” Well, it is true that you do not have to actually pay any federal taxes, but the $7,000 is subject to gift taxes… it is just that Uncle Sam has graciously given you an additional lifetime bank of $1,000,000 to draw against before, as the giver, you have to take money out of your pocket when you give a gift. That’s the good news. The bad news is that every dollar you draw against is decreasing the amount you are allowed to give away upon death without estate taxes. The current federal exemption is $3,500,000, and in 2011 drops to $1,000,000.

Confused yet? Here’s an example that illustrates both the gift tax and estate tax problem of using joint property:

Carlos and Dave are committed domestic partners, and, based on the advice they got from their cable guy Larry, decide to put all of their assets into joint tenancy. This means that all of Carlos’ previously separate accounts now have Dave listed as an owner and vice versa. Carlos has only a house worth $500,000 and Dave has a mutual fund worth $500,000. After they put each other’s name on the title to the house and the mutual fund, they decide to talk to their accountant.

The accountant gave them the bad news that Carlos actually gave a gift of $250,000 to Dave, the first $13,000 of which is exempt, leaving a taxable gift of $237,000 from Carlos to Dave. Assuming Carlos started with the whole $1,000,000 in lifetime gift tax credits, we subtract the $237,000 from the $1,000,000 leaving $763,000 that can be gifted in the future (beyond the $13,000 annual exclusion), and only $3,263,000 that can passed from Carlos to Dave, or anyone else for that matter, without estate taxes. The same is now also true of the gifts given from Dave to Carlos.

For many people, that may not sound so terrible, but imagine if Dave and Carlos did not go to their accountant and fill out the proper gift tax forms. That’s when you usually hear two of the IRS’ favorite words—“interest” and “penalties.” There is also a huge potential state gift tax problem, depending on the state you reside in. For example, in North Carolina this would have actually resulted in an immediate tax of $26,710 due from Carlos and the same from Dave. A total of $53,420 in taxes would have to be paid, out of pocket and right away, as a result of retitling these two accounts. (I wonder if the cable guy Larry has legal malpractice insurance?)

All of this came about because Carlos and Dave wanted to combine their property as one family unit, something previously discussed as being a top goal of many committed domestic partner couples. While it simply does not sound “right” to a lot of people since they believe they should be able to give their property to anyone they choose without being taxed, I can assure you that this tax is very real. And, no, this tax does not affect married couples at all because they have something called the “unlimited marital deduction,” which allows unlimited gifts and unlimited inheritance without taxes for U.S. Citizen spouses.

“That’s not fair!” you may now be shouting. “That’s discrimination!” And you’re right. But there is a solution that allows the combination of assets without incurring any of the gift taxes. The solution is a joint revocable living trust with a domestic partnership property agreement.

To keep things brief, a revocable living trust is a document set up during a person’s life that allows them to retitle their property into the name of the trust and still remain in control of everything because they are the trustee. For a couple, they create a joint trust where both of them are trustees, and now both Carlos and Dave could access and control all of their assets and accounts. In addition, the domestic partnership property agreement lists that although the house and the mutual fund are in the name of the jointly owned and controlled trust, the house is still technically owned separately by Carlos and the mutual fund is still technically owned separately by Dave.

Again, the revocable living trust is a major topic in the book Estate Planning for Domestic Partners and it is well worth reading, especially if you and your partner are considering having one. In addition, we will discuss some of the other, non-gift tax benefits of a revocable living trust in the second pitfall. However, if you are already convinced that a revocable living trust with a domestic partnership property agreement is for you, then I strongly suggest that you seek out an attorney who is experienced in helping domestic partner couples draft these kinds of trusts. We will also discuss what an experienced attorney is in Pitfall Five. For a list of attorneys with advanced training, please go to the website www.NIDPestateplanning.com for a listing of members of The National Institute for Domestic Partner Estate Planning.